Friday, May 14, 2010

Markets Run Amuck – Part I

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)

Let me start off by apologizing for not posting this last week.  As the markets were supposedly coming unglued, I was in the midst of trying to attend four conferences in a row in Florida along with spending some time with my family in Orlando.  I ended up attending three of the conferences, had my first Hole-In-One and most importantly, was able to take my family to Disney before heading over to Fort Lauderdale for the annual NFL Players Association Financial Advisor meeting. 

While the Hole-In-One was definitely exciting and something that’s eluded me for 37 years playing golf, there was nothing better than watching my kids enjoyment level hit all time high levels as they ran around the various Disney parks with our whole extended family!  Getting back to the NFL conference, I met some truly special players who agreed to be interviewed for this blog and share their stories.  I think you will be very surprised.  It’s going to take me some time to get this all organized, but you can plan on reading more as summer hits.

So, I am sitting at lunch last Thursday (May 6), watching the market through my phone.  As you can see from the chart below, it had been weak for the past week or so, a pullback I had been expecting, wrongly so,  for some time based on the fears of Greece defaulting on their bonds and that spreading to the other PIIGS countries: Portugal, Ireland, Italy and Spain.  Since markets have become so globalized and connected over the past 10 years, such problems would certainly have ripple effects on our shores.  In my 11 Shockers for 2010, I listed a European government debt default and subsequent run on the Eurozone as a potential disaster.

Getting back to May 6, the markets were all weak as lunch finished up and I headed back to my room to prepare some buy orders for the close. As you can see from the chart below, the Dow was down 400, and it had the feel of more selling coming during the final hour and the potential for a turnaround on Friday as the most important economic report of the month, the employment figures, was scheduled to be released at 8:30am. What happened that afternoon was simply incredible and something I have only seen a handful of times, if that, in my 22 year career.

Those of who are active in the markets probably know that the final 90 minutes are often the most important and interesting of the day. We typically see the final wave of margin calls between 2:30pm and 3:00pm and many mutual funds begin to see their inflows and outflows beginning at 2:30pm. The treasury bond market also closes at 3:00pm, so volatility usually increases as managers rebalance their asset allocations at that time. There’s an old traders adage that says “never trust a rally that begins before 2:30pm” when looking for the market to reverse a downtrend.

As 2:30pm hit, a tsunami of selling hit the market. The following is a 1 minute chart so you can really see what happened. Each colored bar represents 1 minute of trading. The chart above shows you what happened from the opening at 9:30am until just before 2:30pm. The next chart below shows you the action over the next 15 minutes.

During this crashette or mini crash, the Dow imploded another 600 points in 15 minutes and my first reaction was that of a geopolitical event, like an attempted assassination on the president or another world leader or some kind of nuclear terrorist attack. It looked liked trading was about to be halted as stocks reached one of the circuit breakers instituted since the 1987 Crash and then I figured it would be closed for the day and open down another 1000 points on Friday as the world digested whatever was going on.

That was until the next 10 minutes hit as stocks reversed course on a dime and soared higher by 500 Dow points. At that point, I started scratching my head and thinking about trader error.

Zooming out a little so that each bar represents 5 minutes of activity, you can get a better idea of the whole day. Stocks were weak, crashed and then snapped back to pre-crash, but still weak levels.

Within minutes of the snapback, the media began floating the idea of a fat finger error, where someone meant to sell millions in stock, but ended up selling billions in stock. While that’s perfectly logical and does happen from time to time, I was dubious right from the start that a single trader could cause such a widespread collapse.

Additionally, as the market was cascading lower, I called up a watch list of some 200 stocks and exchange traded funds (ETFs) to see how they were individually behaving. A fat finger error would certainly not implode every stock. But what I saw was simply amazing.

Bids, the price and amount of stock someone is trying to buy below the current price, completely evaporated, something I’ve only seen during the Crash of 1987, mini crash of 1989 and 1998 and maybe another time during 2008. Traders and investors en masse looked as though they all ran for the hills. At the same time, someone or SOMETHING continued bombarding the market with sell orders of all size, regardless of price.

That last sentence is key. “someone or SOMETHING” and “regardless of price”.

What the heck happened?

Next week, in part II of this topic, I will discuss what I believe occurred, who will be blamed and what should be done in the future.

Stay tuned!
Speaking of tuning in, if you are interested, I will be interviewed on WTNH this Sunday, May 16, between 7:15am and 7:35am. Additionally, I will be on CNBC’s Worldwide Exchange this Tuesday, May 18 from 5:30am to 5:55am.

Please feel free to email me with any questions or comments at

Until next time…

Paul Schatz

Heritage Capital LLC

1 comment:

  1. Computers should not be allowed to trade any more than personal information databases should be allowed on laptops. Both concepts are absurd. Databases because people are not responsible enough and trading because computers cannot be held responsible. Real people get hurt both ways.